Definition of Business Entities – What is What?

Michael Lodge

by Michael Lodge

We form business entities for our clients and the question always comes up what is what?  So lets go over what a Closely Held Corporation is, a Personal Holding Company and Personal Service Corporation – as described by the Internal Revenue Service.  When trying to explain to clients what is what you see a dazed look come over their eyes.  Sometimes I get that way to at the end of a long day explaining issues to clients.  Here we go.

Question: Can you give me plain English definitions for the following: (1) a closely held corporation, (2) a personal holding company, and (3) a personal service corporation?

Answer:

Generally, a closely held corporation is a corporation that:

  • Has more than 50% of the value of its outstanding stock owned (directly or indirectly) by 5 or fewer individuals at any time during the last half of the tax year, and
  • Is not a personal service corporation.

A closely held corporation is subject to additional limitations in the tax treatment of items such as passive activity losses, at-risk rules, and compensation paid to corporate officers.

Refer to Publication 542, Corporations, for more information.

Personal Holding Company

A corporation will be considered a personal holding company if it meets both the Income Test and the Stock Ownership Test.

  • The Income Test states that at least 60% of the corporation’s adjusted ordinary gross income for the tax year is from certain dividends, interest, rent, royalties, and annuities.
  • The Stock Ownership Test states that at any time during the last half of the tax year, 5 or fewer individuals must directly or indirectly own more than 50% in value of the corporation’s outstanding stock.

Refer to the Instructions for Schedule PH (Form 1120), U.S. Personal Holding Company (PHC) Tax, for more information and for a list of exceptions.

Personal Service Corporation

  • Its principal activity is performing personal services during the “testing period.”
  • Its employee-owners substantially perform the services. A corporation meets this requirement if more than 20% of the corporation’s compensation cost for its activities of performing personal services is for personal services its employee-owners perform during the testing period.
  • Its employee-owners own more than 10% of the fair market value of its outstanding stock.
  • Personal services include, but are not limited to, any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law firms, and the performing arts.

Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of:

A. The last day of its tax year, or
B. The last day of the calendar year in which its tax year begins.

Refer to Publication 542 for more information.

If you have any questions please direct them to:  tax@icontaxgroup.com